Capitalism

Markets Work Because of Dumb Luck and Inefficiency

The great mistake of market lovers

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By Rory Sutherland

The greatest mistake made by conservatism was its overly close relationship with neo-classical economics. This was a marriage of convenience: finding themselves Johnny-no-mates in the academic world, the conservative establishment hastily bunked up with the only group of social scientists who were prepared to talk to them.

This cohabitation was not only unhealthy but boring. Economics is obsessed with a very narrow definition of efficiency, beyond which it can see no other virtues. It hence turns political rhetoric into a slightly Aspergic narrative about efficiency and growth — as though Churchill had urged us to fight the second world war ‘to regain access to key export markets’.

But this efficiency obsession also leads conservatives to defend free market capitalism on fallacious grounds. In truth free markets are not really efficient at all. Admiring capitalism for its efficiency is like admiring Bob Dylan for his mellifluous singing voice: it is to hold a healthy opinion for an entirely ridiculous reason.

The market mechanism is loosely efficient. But the idea that efficiency is the main virtue of free markets is wrong. Competition itself is highly inefficient. In my home town, I can buy food from about eight different places; I’m sure this system could be much more ‘efficient’ if Waitrose, M&S and Lidl were forcibly merged into one huge ‘Great Grocery Hall of The People No. 1306’. I am equally confident that after a few initial years of success, the shop would be terrible.

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The missing metric here is semi-random variation. Truly free markets trade efficiency for a costly process of market-tested innovation heavily reliant on dumb luck. The reason this inefficient process is necessary is that, though we pretend otherwise, no one knows anything about anything: most of the achievements of consumer capitalism were never planned; they are explicable only in retrospect, if at all.

The reason to avoid communism is not because it is inefficient, but because it tries to be too intelligent. Communism might be able to build a boring bridge or lathe factory, but it could never have created Red Bull: no bureaucracy could ever muster the level of insanity necessary to try charging £2 for a slightly disgusting drink in a tiny can. Its popularity defies explanation: it is the duck-billed platypus of the carbonated drinks world.

It’s not just that we don’t know what we want: we don’t even know why we value the things we already have. Most people think they own a dishwasher to clean crockery. But perhaps the greatest value you get from owning a dishwasher is that it gives you somewhere to keep dirty dishes out of sight. (More controversial is my theory that cycling is an excuse for Lycra fetishists to appear in public.)

The fact that we don’t consciously know why we do what we do is crucial. Amazon’s stock-market valuation has just crept above Walmart’s, even though its sales are barely 15 per cent of its larger competitor’s. People who admire only efficiency (i.e. almost everyone in finance) cannot help but see Amazon as a more efficient alternative to Walmart, and invest on that premise. But their definition of retail efficiency may be dangerously narrow. People go shopping not only to buy things, but for the small social interactions afforded by leaving the house. The assumption that the ‘more efficient’ but impersonal online model will always triumph may be wrong.

The guarantee of a pleasant social interaction to anyone possessed of a £5 note may, in fact, be the single greatest defence of free markets. Put simply, capitalism pays people to be nice. A Chinese proverb sums it up perfectly: ‘If you find it difficult to smile, do not open a shop.’

15 September 2015


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  • A clever and funny article. Thank you.

    The reference to neoclassical economics was a bit of a turn-off. Please don’t explain what it is, I couldn’t care. It would be better if the theoretical aspect of the “much disapproved of thing” was actually referenced, without that jingoistic handle.

    In regard to the substance of the article, when I was a high school student, more than half a century ago, it seems to me that communism was naturally “more efficient” than communism, but even then there was something about communism that I did not like, even if it was “more efficient.”

    As an accountant, I loved cost accounting and working out actual costs in complex situations. I also was an advocate of variable costing, where the accounting system reflected the underlying economic reality of the firm.

    The limitation of accounting theory of variable costing was it appeared to deal with complexity, but it didn’t force an answer to the main question. Were there parts of the business that should be cut off, or severely restructured? Instead, it allowed unprofitable parts of the business to continue even though they did not make a profit after all costs were taken into account – it was enough that they made a “contribution” to the full-firm’s profit.

    Indeed, at the time, one of the emphases in academic accounting was in dealing with the difficult issue of in-house supply or external sourcing in the case of a complex business with multiple divisions. Following variable costing principles, in-house supply naturally was usually favoured.

    New management came in to the business with which I was involved, and it forced the question of the viability of each division. This approach required a great simplification of the business into discrete divisions, each with its own profit statement. I endorsed this approach, and changed the accounting system accordingly. Furthermore, each division was required to stand on its own feet.

    From my own perspective, managing complexity was great fun, and provided a chance to exercise my own particular talents. However, for the business as a whole, simplifying management had greater rewards, as was obvious to me by that time.

    My experience confirms for me what the author says, “Truly free markets trade efficiency for a costly process of market-tested innovation heavily reliant on dumb luck. The reason this inefficient process is necessary is that, though we pretend otherwise, no one knows anything about anything: most of the achievements of consumer capitalism were never planned; they are explicable only in retrospect, if at all.”

    Let us go for simplicity, and not complexity, in economics. That also means that we have to let go of the ambition to manage the world as one gigantic economic pudding. It will never work. Only national governments can truly manage their economies for the benefit of their own people. Only where (economic) democracy flourishes will George Cooper’s circular flow of money really work as a force to reduce inequality and increase everyone’s prosperity.

    • Swami Cat

      Great comment, GL

      I would add that the issue of ignorance is actually multiple levels deep. At the first level we admit we don’t really know what the solution is. This leads to Campbell’s basic algorithm of experiment — we try various things and see what works.

      But at the deeper level we aren’t even sure exactly what the problems are. We have various contexts, goals, tradeoffs and values, and a problem for one person at one time or place may be a great thing for someone else. In addition a lot depends on how the problem is framed. Is the problem inequality or poverty? Preserving jobs or increasing wages? Distribution of the productive value or its creation? Are temperatures going to be warmer or cooler and exactly what temperatures do we or should we even prefer?

      We are not sure nor are we of a single mind on either the questions or the answers. Master planning often assumes both.

      • Thanks.

        I can see that my “simplicity model” requires one to intuitively accept a particular set of goals. This works well in a political context, where any political party can clearly articulate its goals has an advantage at the ballot box.

        In Australia, that has worked with both major parties defining the nation as an “aspirational society”. This approach has encouraged innovation and creativity, even though it leaves behind those with less natural ability and poorer training. As a corrective, I would like to see our parties also adopting the aim of a job for people of every skill and education level. This requires some re-thinking when considering trade policies – we are a long way from being able to do that!

        I am not sure what the set of goals that are driving the EU, but they also seem to be a long way from adopting my new mantra. The results of EU thinking can be seen in Spain and Portugal, where young people of ALL skill levels appeared to be left at the job queue, with little prospects. This is also a question of trade policy, which the Euro experiment has exacerbated. (At least in Australia, the unexpected drop in the $A has given its industry new life – we were in danger of achieving “unemployed prosperity” from the mining boom and massively favourable terms of trade.)

        In the northern hemisphere, when we look at the fixes proposed by Jeremy Corbyn and Bernie Sanders we come face to face with your issue of “framing the problem”. They both seem to be inclined to see greedy capitalists as a core issue. Yet greed has not changed much since the time of Adam Smith. Yet, one element that has changed is the global environment. This has allowed Ricardo’s theory to be widely implemented. The result is that capital is able to chase the cheapest available labour anywhere in the world. (Who can be surprised by the consequential threat of deflation?)

        At least the world’s economists share a single mind on this subject of Ricardo-ism. This should be a warning for all: if the premises of a consensus are wrong, we are all in big trouble.

        • One-Love

          Boy you guys are intellectually stimulating. If ever you are planning on vacationing on St. Maarten or Anguilla let me know so we can link up and have some great conversations.

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  • Douglas Levene

    Isn’t the author saying that capitalist competition is inefficient in the short run but efficient in the long run?

  • Ciro D’Araujo

    The same reason why dictatorship is substantially more efficient in enacting laws and policies but we stick with democracy anyways – because democracy also makes it much harder to screw up.

  • The author of this bizarre piece doesn’t understand what “efficient” means in economic jargon. “Efficient” doesn’t mean, as the author apparently imagines, “lowest cost, no matter what.” Merging multiple shops into “Great Grocery Hall of The People No. 1306” is not more “efficient” than having multiple choices. It is not “more efficient” to buy things online if in fact people prefer to pay more but obtain other benefits such as social interactions at a local store.

    “Semi-random variation” is not a “metric,” and not a… thing. The author really needs to stop using jargon with which he’s not familiar. If he means stochastic processes, apparently in the context of innovation, then he will happy to learn that such considerations have long been central to economic thought.

  • There is some truth in the “socratean” perspective of ‘I know that I know nothing’ in this article.